Prevention and Treatment in Environmental Policy Design,

In many environmental contexts, the damages that result from some externality-generating activity can be reduced either through prevention prior to the occurrence of the event or treatment after that occurrence. The existing literature has focused on the use of prevention. Only Polinsky and Shavell [11] consider explicitly the use of mitigation, but their analysis is limited to the case of Pareto efficiency. In reality, policymakers often pursue other objectives, such as minimizing damages subject to a budget constraint or minimizing the cost of maintaining a certain safety level. This paper provides an analytical framework for examining the choice of prevention vs treatment in the context of these alternative behavioral assumptions. It considers first the case where the effectiveness of treatment is known at the time that the allocation decision must be made. We then extend the analysis to the case where the effectiveness of treatment is uncertain and develop a framework for addressing the tradeoff between prevention and treatment under a “safety” rule. In both cases, we examine the factors that influence the allocation of resources between prevention and treatment and show that these factors can affect the second best allocations of resources in ways that are contrary to the effect under the Pareto efficient allocation.